Less than nine months ago, I released an analysis about Samsung (OTC:SSNLF) where I explain why its market capitalization did not reflect the fair value of the company. At that time, the shares traded at an incredibly cheap price-to-earnings ratio (around 10-11). Since then, the share price rose to over $1,600 from around $1,100, representing an appreciation of +45%. I have to mention that this honorable performance has been achieved despite the gray swan encountered the last quarter in 2016 with the recall and sales cancellation of the Samsung Note 7. The battery issue negatively impacted earnings by $5 billion.
In this article, I will discuss the financial results for the 2016 fiscal year, expectations for 2017, and the medium-term future (5-10 years).
2016 was a Good Year
In its last earnings release, Samsung unveiled the revenue and profit for the 2016 fiscal year. The revenue is quite stable at $171.6 billion compared to $170.5 billion in 2015. But, in the same time, the operating profit rose to $24.9 billion from $22.4 billion in 2015 (+11% in USD).
In 2016, shareholders' equity rose to $164 billion from $152.2 billion in 2015 (+7.9% year over year).
During the same period, Samsung had a massive share buyback. The total share number (common and preferred) decreased by more than 3%. So, the growth of the net active value per share is even better. In 2016, the company also increased its dividends by 30% to $3.5 billion.
In 2016, all the divisions exhibited great figures. The revenue remained almost stable for all the divisions.
But the operating profit rose by +111% for Consumer Electronics, +6.7% for IT & Mobile Communications, and +6.3% for Device Solutions.
Consumer Electronics profit was boosted by the strong sales of premium products (mainly Samsung Ultra High Definition and Curved TVs).
Despite the Note 7 issue, Mobile Communications profit was supported by the good sales of S7 and S7 Edge. In addition, it has to be mentioned that mid- to low-end products maintained a solid profitability.
The Device Solutions division continued to perform remarkably well. The semiconductor business accounts for 86% of the operating profit of this division. It encountered a demand increase and solid earnings for memory, DRAM, NAND, and system LSI. The Device Solutions division is, for the second year, the main source of profits; it contributed 54% of the company's operating profit.
Three weeks ago, Samsung announced that the Q4 operating profit was up 50% year over year, mainly boosted by the rise in the semiconductor division profit, which was +77% year over year. The strong Q4 2016 results suggest positive prospects for 2017.
Expectations for 2017
In the Q4 reporting, the company unveiled the outlook for 2017. Demand and earnings should remain strong for the Device Solutions division. Samsung expects to expand sales of the high value-added DRAM products.
The company expects the smartphone market to slow down. Samsung will release the new version of its flagship smartphone, the Galaxy S8, during the first semester of 2017 (possibly mid-April). The company expects to sell 60 million Galaxy S8s. This goal is higher than for the previous flagship smartphone; the S7 had a target of 48 million units.
The company already announced it will pursue the share buyback. Samsung will buy back approximately $8.1 billion worth of shares, which represents about 3% of the current market value.
I would like to emphasize the bright future of smartphones.
In my previous article, I mentioned that Samsung is working hard on foldable screens. We have no certitude that such a device will be commercialized in 2017. However, the development of this breakthrough technology is still in process. Experts suggest that a prototype could be unveiled at the Mobile World Congress in Barcelona at the end of February. For the obvious reason of visual comfort, especially with aging consumers, the coming of larger screens is the next big step forward, in the same way that TV screens have grown from around 12 inches in the '70s to over 40 inches nowadays.
As you may have noticed, the new high-end smartphone technical specifications are quite impressive and are close to those of basic desktop computers. In the medium term (5-10 years), smartphones will likely be the only computer device for average users and also for domestic use. The smartphone's interface could be wirelessly displayed on a larger screen (TV or dedicated screen) while mouse and keyboard could be connected by Bluetooth or equivalent technology, helping the users to achieve usual tasks like text and spreadsheet processing. Also, smartphone camera performance is reaching a point where many people do not anymore see the benefit to buy a dedicated camera.
Smartphone functionality improvement not only relies on the technical specifications, but also the uses and the way this device accompanies people's lives. For example, the device is expected to become a common means of payment for small transactions (Apple (NASDAQ:AAPL) Pay, Samsung Pay).
So, the big picture includes two milestones. First, with foldable screens, smartphones will kill the tablet market. Then, with higher performance specifications, smartphones will substitute personal desktop computers, signing the death of the latter devices. Such technological evolutions already killed the MP3 player and the external automotive GPS.
In a more general manner, I think most investors neglect the fantastic prospect of the smartphones. Investors fear that the margin of the high-end smartphones could be durably deteriorated by the coming of the Chinese cost-killers with comparable technical specifications. But in the same way that the automobile industry is continuously improving the comfort and performance of its products, smartphones' improvement is a never-ending story. Like most of the electronic devices commercialized during the last 30 years, customers update their smartphones every few years.
All the new uses will require to improve hardware specifications, and this is precisely the second activity of Samsung. So, the good point is that even if the company's smartphone market share drops due to the predatory pricing of its competitors, it remains the main supplier of microelectronic components. Keep in mind that Device Solutions accounts for over 50% of the company's profit.
The current market capitalization is around $260 billion. According to the last earnings release, the annual net profit was $18.2 billion for 2016. So, the shares are currently trading at a price-to-earnings ratio of around 14. This figure looks relatively modest compared to the current S&P 500 PE ratio exceeding 26. Not only is the price-to-earnings ratio modest, but also, as I mentioned above, at the end of 2016, the company reported a cash position and shareholders' equity of $76.7 billion and $168 billion, respectively. Given these figures, the market capitalization looks even more attractive.
To summarize the current situation. Operating results for 2016 were excellent. The last-quarter results and Samsung's outlook suggest that 2017 will be even better than 2016. In the medium term, the use of smartphone in people's lives is poised to expand further.
Last year, the company has generously rewarded shareholders with a massive share buyback and dividend increase. It already announced a new, massive share buyback program for 2017, and indicated that 50% of the free cash flow will be returned to shareholders. The company sits on a huge cash position. Samsung maintains significant investments, and has a considerable research and development budget.
Given these facts, Samsung's share price looks very attractive and deserves a place in the portfolio of long-term investors. Because of its strong balance sheet and projected earnings for 2017, I see a very low downside risk. Actually, the share price deserves an immediate appreciation of +20% to reach its fair value.
Note: All the graphics presented in the article were produced using the data available in the reports of the company.
Disclosure: I am/we are long SSNLF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.